Morningstar DBRS Upgrades North American Financial 15 Split Corp.'s Preferred Shares to Pfd-3 (low)

DBRS Limited (Morningstar DBRS) has upgraded its credit rating on the Preferred Shares issued by North American Financial 15 Split Corp. (the Company) to Pfd-3 (low) from Pfd-4. The rating upgrade takes into consideration the increase in downside protection to 45.5% as of January 15, 2025, from 32.7% as of January 31, 2024, the decrease in the Preferred Shares' distribution rate to 8.75% annually on the Preferred Share's redemption value of $10 for the fiscal year beginning December 1, 2024, from 9.5% annually for the fiscal year beginning December 1, 2023, the dividend coverage ratio of 0.4 times (x), a projected grind of 6.1% per year over the remaining term and unhedged foreign currency exposure.

The Company invests in a portfolio (the Portfolio) consisting primarily of common shares of 15 high-quality North American financial services companies: Bank of America Corporation; Bank of Montreal; The Bank of Nova Scotia; Canadian Imperial Bank of Commerce; CI Financial Corp.; Citigroup Inc.; The Goldman Sachs Group, Inc.; Great-West Lifeco Inc.; JPMorgan Chase & Co.; Manulife Financial Corporation; National Bank of Canada; Royal Bank of Canada; Sun Life Financial Inc.; The Toronto-Dominion Bank; and Wells Fargo & Company. The Company may invest up to 15% of the net asset value (NAV) in securities of issuers other than the core 15, and no more than 10% of the NAV may be invested in any single issuer. As of May 31, 2024, 11.3% of the Portfolio was also invested in Fifth Third Bancorp, U.S. Bancorp, and Morgan Stanley, and 6.7% was held in cash. Quadravest Capital Management Inc. is acting as the manager (the Manager) for this Company.

A portion of the Company's Portfolio is exposed to currency risk as it includes securities denominated in U.S. dollars (USD), while the NAV of the Company is expressed in Canadian dollars. The Company has not entered into currency hedging contracts for the USD portion of the Portfolio, although the Company may use derivatives for hedging purposes. As of May 31, 2024, 61.6% of the Portfolio was invested in USD-denominated assets.

The Company has an at-the-market equity program (the ATM Program) that allows the Company to issue Preferred Shares and Class A Shares to the public from time to time at the Company's discretion, effective until October 6, 2026, unless terminated prior to such date by the Company. The maximum gross proceeds from the issuance of the shares will be $350 million. During the six-month period ended May 31, 2024, 1,829,400 Preferred Shares were sold through the ATM Program at an average selling price of $10.17 per Preferred Share, raising gross proceeds worth $18.6 million. During the same period, 991,200 Class A Shares were sold through the ATM Program at an average selling price of $5.61 per Class A Share, raising gross proceeds worth $5.6 million.

The Company's termination date can be extended for additional terms of five years at the Company's discretion, but shareholders will be provided with a special retraction right in connection with such extension. On March 12, 2024, the Company announced the extension of the termination date of the Company for a further five-year period from December 1, 2024 to December 1, 2029. In connection with the extension of its term, holders of the Preferred Shares were provided with a special retraction right that allowed them to tender one or both classes of shares and receive a retraction price based on the November 29, 2024, NAV per unit (Unit, consisting of one Preferred Share and one Class A Share). At maturity, the holders of the Preferred Shares will be entitled to the value of the Company, up to the face amount of the Preferred Shares, in priority to the holders of the Class A Shares. Holders of the Class A Shares will receive the remaining value of the Company.

The Preferred Shares dividend rate is set by the board of directors annually and is subject to a minimum of 7.0% annually until 2029. The Preferred Share dividend rate for the fiscal year commencing December 1, 2024 was set at 8.75%, 75 basis points below the dividend rate set for the prior year. Holders of the Class A Shares are currently receiving monthly distributions of $0.11335 per share, equivalent to 9.1% per annum on the issue price of $15. No distributions will be paid to the Class A Shares if the NAV per Unit falls below $15.

As of January 15, 2025, the asset coverage ratio was at 1.8x. The downside protection available to holders of the Preferred Shares has increased to 45.5% from 32.7% a year ago. The dividend coverage remains at 0.4x, indicating that the current dividend income earned by the Company is not enough to fully cover the Company's expenses and targeted distributions on the Preferred Shares. Without giving consideration to capital appreciation potential or any source of income other than the dividends earned by the Portfolio, the current Preferred Share dividends together with the distributions on the Class A Shares will create a projected grind on the NAV of the Portfolio of approximately 6.1% per year for the remaining term of the Preferred Shares. To supplement the Portfolio income, the Company may engage in covered call options or cash covered put options on all or a portion of the shares held in the Portfolio.

The main constraints to the credit rating are the following:

(1) Volatility in stock prices, along with changes in the dividend policies of the underlying issuers, may result in significant reductions in the Preferred Shares' dividend coverage or downside protection from time to time.

(2) A Preferred Shares' dividend coverage that is less than one time.

(3) Reliance on the manager to generate a high yield, through methods such as option writing, on the investment portfolio to meet distributions and other expenses without having to liquidate portfolio securities.

(4) The monthly cash distributions to holders of the Class A Shares which create grind on the Portfolio. This risk is mitigated by a NAV test.

(5) The concentration of the Portfolio in one industry.

(6) The unhedged portion of the USD-denominated Portfolio that exposes the Portfolio to foreign currency risk.

Morningstar DBRS' credit rating on the Preferred Shares addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are the cumulative preferential monthly cash dividends and the return of the original issue price of $10 per Preferred Share to holders of the Preferred Shares on the termination date.

Morningstar DBRS' credit rating does not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology applicable to the credit rating is Rating Canadian Split Share Companies and Trusts (June 21, 2024) https://dbrs.morningstar.com/research/434794.

Other methodologies referenced in this transaction are listed at the end of this press release.The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info-DBRS@morningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/410863.

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.